1. 1 Objective – Students will be able to answer questions regarding foreign exchange. SECTION 1 Chapter 38- Foreign Exchange © 2001 by Prentice Hall, Inc.

2. Foreign Exchange (FOREX) The buying and selling of currency Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their Dollars and buy Euros. Any transaction that occurs in the Balance of Payments necessitates foreign exchange The exchange rate (e) is determined in the foreign currency markets. Ex. The current exchange rate is approximately 8 Yuan to 1 dollar Simply put. The exchange rate is the price of a currency.

3. Changes in Exchange Rates Exchange rates (e) are a function of the supply and demand for currency. An increase in the supply of a currency will decrease the exchange rate of a currency A decrease in supply of a currency will increase the exchange rate of a currency An increase in demand for a currency will increase the exchange rate of a currency A decrease in demand for a currency will decrease the exchange rate of a currency

4. Appreciation and Depreciation Appreciation of a currency occurs when the exchange rate of that currency increases (e ↑ ) Depreciation of a currency occurs when the exchange rate of that currency decreases (e ↓ ) Ex. If German tourists flock to America to go shopping, then the supply of Euros will increase and the demand for Dollars will increase. This will cause the Euro to depreciate and the dollar to appreciate.

5. Increase in interest rates in U.S. relative to France. If you lived in France, where would you like to invest your hard-earned money? S D P QEuro S1 SupplySupply In the U.S. How do you do it? Go through the-- P1 Q1 S D P QDollar D1 Q1 P1 Buy Dollars INVESTINVEST Receive higher interest rate

6. Q$Q$ S$S$ D$D$ e q S $ .: e (ex. rate) ↓ & Q $ ↑.: $ depreciates relative to € S $ 1 e1e1 q1q1 Increase in the Supply of U.S. Dollars relative to the Euro € / $

7. €/¥ Q¥Q¥ S¥S¥ D¥D¥ e q S ¥ .: e ↑ & Q ¥ ↓.: ¥ appreciates relative to € S ¥1 e1e1 q1q1 Decrease in the Supply of Yen relative to the Euro

8. $/£ Q£Q£ S£S£ D£D£ e q D £ 1 e1e1 q 1 D £ .: e ↑ & Q £ ↑.: £ appreciates relative to the $ Increase in the Demand for the British Pound relative to the U.S. Dollar

9. £/¥ Q¥Q¥ S¥S¥ D ¥ 1 e1e1 q1q1 D¥D¥ e q D ¥ .: e ↓ & Q ¥ ↓.: ¥ depreciates relative to the £ Decrease in the Demand for Yen relative to the British Pound

10. Exchange Rate Determinants Consumer Tastes Ex. a preference for Japanese goods creates an increase in the supply of dollars in the currency exchange market which leads to depreciation of the Dollar and an appreciation of Yen Relative Income Ex. If Mexico’s economy is strong and the U.S. economy is in recession thus creating a fall in the U.S. price level, then Mexicans will buy more American goods, increasing the demand for the Dollar, causing the Dollar to appreciate and the Peso to depreciate.

11. Exchange Rate Determinants Relative Price Level Ex. If the price level is higher in Canada than in the United States, then American goods are relatively cheaper than Canadian goods, thus Canadians will import more American goods causing the U.S. Dollar to appreciate and the Canadian Dollar to depreciate. Speculation Ex. If U.S. investors expect that Swiss interest rates will climb in the future, then Americans will demand Swiss Francs in order to earn the higher rates of return in Switzerland. This will cause the Dollar to depreciate and the Swiss Franc to appreciate.

12. Exports and Imports The exchange rate is a determinant of both exports and imports Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

13. 13 Section 1 Assessment 1. Graph and describe the effect on the European Euro/ U.S. Dollar exchange rate if Americans develop a preference for European made automobiles. 2. Graph and describe the effect on the Chinese Yuan/ U.S. Dollar exchange rate if the Chinese economy has a higher price level then the U.S. economy.

14. 14 Summary: In a paragraph, describe what you have learned today.